Loan Portfolio Management - Office of the Comptroller of ...

A-LPM

Comptroller of the Currency

Administrator of National Banks

Loan Portfolio Management

Comptroller¡¯s Handbook

April 1998

Updated June 26, 2017, for Nonaccrual Status

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Assets

Loan Portfolio

Management

Table of Contents

Overview .................................................................................................... 1

Risks Associated with Lending .................................................................... 3

Credit Culture and Risk Profile .................................................................. 11

Loan Portfolio Objectives......................................................................... 13

Strategic Planning for the Loan Portfolio.......................................... 13

Financial Goals ............................................................................... 14

Risk Tolerance ................................................................................ 15

Portfolio Risk and Reward ......................................................................... 15

The Loan Policy ........................................................................................ 17

Loan Policy Topics .......................................................................... 19

Loan Approval Process ................................................................... 20

Portfolio Management .............................................................................. 22

Oversight ........................................................................................ 22

Risk Identification .......................................................................... 22

Nonaccrual Status ........................................................................... 24

Exceptions to Policy, Procedures, and Underwriting Guidelines...... 25

Documentation Exceptions ........................................................ 25

Policy and Underwriting Exceptions........................................... 26

Aggregate Exception Tracking and Reporting .................................. 27

Portfolio Segmentation and Risk Diversification .............................. 28

Identifying Concentrations of Risk .............................................. 28

Evaluating and Managing Concentrations of Risk ............................ 30

Concentration Management Techniques .................................... 31

Stress Testing ............................................................................................ 32

Allowance for Loan and Lease Losses ........................................................ 33

Credit Management Information Systems .................................................. 34

Collections and Work-out ........................................................................ 35

Lending Control Functions ........................................................................ 37

Independence ................................................................................. 37

Credit Policy Administration ........................................................... 38

Loan Review ................................................................................... 38

Audit .............................................................................................. 39

Administrative and Documentation Controls ................................... 39

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Communication with Senior Management and the Board .......................... 40

Loan Portfolio Management Supervision ................................................... 41

Asset Quality Reviews..................................................................... 41

Targeted Reviews ........................................................................... 42

Process Reviews ............................................................................. 42

Administrative and Documentation Reviews ................................... 43

Compliance Reviews...................................................................... 43

Follow-up Evaluations on Management Commitments .................... 43

Ongoing Supervision ...................................................................... 43

Examination Procedures ............................................................................ 45

General Procedures ........................................................................ 45

Quantity of Risk .............................................................................. 48

Quality of Risk Management ........................................................... 54

Conclusion Procedures ................................................................... 70

Appendixes .......................................................................................... 72

Topics of Loan Policy ..................................................................... 72

12 CFR 30 ¡ª Safety and Soundness Standards ................................ 78

Portfolio Credit Risk Management Processes ................................... 80

Loan Production Offices ................................................................. 85

Loan Participations.......................................................................... 87

Loan Brokerage and Servicing Activities .......................................... 92

IRS Express Determination Letters ................................................... 93

References

.......................................................................................... 97

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Loan Portfolio

Management

Introduction

Overview

Lending is the principal business activity for most commercial banks. The

loan portfolio is typically the largest asset and the predominate source of

revenue. As such, it is one of the greatest sources of risk to a bank¡¯s safety

and soundness. Whether due to lax credit standards, poor portfolio risk

management, or weakness in the economy, loan portfolio problems have

historically been the major cause of bank losses and failures.

Effective management of the loan portfolio and the credit function is

fundamental to a bank¡¯s safety and soundness. Loan portfolio management

(LPM) is the process by which risks that are inherent in the credit process are

managed and controlled. Because review of the LPM process is so important,

it is a primary supervisory activity. Assessing LPM involves evaluating the

steps bank management takes to identify and control risk throughout the

credit process. The assessment focuses on what management does to identify

issues before they become problems. This booklet, written for the benefit of

both examiners and bankers, discusses the elements of an effective LPM

process. It emphasizes that the identification and management of risk among

groups of loans may be at least as important as the risk inherent in individual

loans.

For decades, good loan portfolio managers have concentrated most of their

effort on prudently approving loans and carefully monitoring loan

performance. Although these activities continue to be mainstays of loan

portfolio management, analysis of past credit problems, such as those

associated with oil and gas lending, agricultural lending, and commercial real

estate lending in the 1980s, has made it clear that portfolio managers should

do more. Traditional practices rely too much on trailing indicators of credit

quality such as delinquency, nonaccrual, and risk rating trends. Banks have

found that these indicators do not provide sufficient lead time for corrective

action when there is a systemic increase in risk.

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Effective loan portfolio management begins with oversight of the risk in

individual loans. Prudent risk selection is vital to maintaining favorable loan

quality. Therefore, the historical emphasis on controlling the quality of

individual loan approvals and managing the performance of loans continues

to be essential. But better technology and information systems have opened

the door to better management methods. A portfolio manager can now

obtain early indications of increasing risk by taking a more comprehensive

view of the loan portfolio.

To manage their portfolios, bankers must understand not only the risk posed

by each credit but also how the risks of individual loans and portfolios are

interrelated. These interrelationships can multiply risk many times beyond

what it would be if the risks were not related. Until recently, few banks used

modern portfolio management concepts to control credit risk. Now, many

banks view the loan portfolio in its segments and as a whole and consider

the relationships among portfolio segments as well as among loans. These

practices provide management with a more complete picture of the bank¡¯s

credit risk profile and with more tools to analyze and control the risk.

In 1997, the OCC¡¯s Advisory Letter 97-3 encouraged banks to view risk

management in terms of the entire loan portfolio. This letter identified nine

elements that should be part of a loan portfolio management process. These

elements complement such other fundamental credit risk management

principles as sound underwriting, comprehensive financial analysis, adequate

appraisal techniques and loan documentation practices, and sound internal

controls. The nine elements are:

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Assessment of the credit culture,

Portfolio objectives and risk tolerance limits,

Management information systems,

Portfolio segmentation and risk diversification objectives,

Analysis of loans originated by other lenders,

Aggregate policy and underwriting exception systems,

Stress testing portfolios,

Independent and effective control functions,

Analysis of portfolio risk/reward tradeoffs.

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